Major Lease Accounting Change: Audit Required?

Could Your Business Be Pushed Into Audit?

The Financial Reporting Council (FRC) has issued final amendments to FRS 102, introducing a major overhaul to how leases are accounted for under UK GAAP. While there are a number of amendments to the standard, the most significant for many businesses is the new requirement to bring most leases onto the balance sheet.

Current Standard: Operating vs Finance Leases

At present, under FRS 102, leases are classified as either:

• Finance Leases (On Balance Sheet)

  • Recognise an asset and a liability at the start of the lease
  • Depreciation and interest expense recognised in profit & loss

• Operating Leases (Off Balance Sheet)

  • Lease payments expensed to profit & loss as incurred
  • No asset or liability recognised

Broadly, finance leases transfer substantially all the risks and rewards of ownership to the lessee, whereas operating leases do not.

New Standard: Almost All Leases on Balance Sheet

From accounting periods beginning on or after 1 January 2026 (or years ending 31 December 2026), most leases will need to be recognised on the balance sheet as a right of use asset with a corresponding lease liability (initially at the same amount in most cases).

Comparative figures are not restated, so these changes apply prospectively from the first year of adoption.

Exceptions Include:

• Short term leases (12 months or less, with no purchase option), or
• Low value assets

What Is a Low Value Asset?

While there is no monetary threshold set in the standard, guidance follows IFRS 16, suggesting that items such as laptops, tablets, small office furniture, and telephones could qualify as low value.

Assets that specifically do not qualify as low value include:

• Buildings and property
• Vehicles
• Large machinery and equipment

What This May Mean for Your Business

Could You Be Pushed Into an Audit?

Recognising leased assets on the balance sheet will increase your gross assets, potentially moving a small company into the medium category and triggering an audit requirement for the first time. For example, including a building or office lease, with a long term still to run, on the balance sheet could have a major impact on the company’s gross asset total.

More details on company size limits can be found here.

Impact On Financial Ratios and Covenants

• Gearing ratios — liabilities will increase, which can affect perceived financial strength.
• Return on assets — larger asset bases may dilute returns.
• Covenants — increased debt levels could risk breaching existing bank or lender covenants.

Are Micro Entities Caught?

No, micro entities applying FRS 105 accounting standard are not affected by these new lease accounting rules and can continue using simpler treatments.

Final Thoughts

This is one of the most significant changes to UK GAAP in recent years and will reshape how many businesses present their financial position. It is crucial to act early and identify all lease arrangements and decide on a policy for what will be treated as low value (as there is no fixed monetary definition in the standard), and see if you will now require your accounts auditing each year.

Get In Touch

If you’d like to understand the impact on your business and start preparing, please contact your local Whitings office or your usual Whitings contact.